Funds’ Use of Options and Volatility-Based Products – New Research and Indexes

In my business travels to discuss the topic of options and volatility-based investment strategies, I often hear questions such as – “What funds are engaging in options and volatility-based investment strategies, and how is their performance?” Again I heard this question this past week in meetings with investors in Hong Kong and Shanghai.
On Monday, September 28 at the Fourth Annual CBOE Risk Management Conference (RMC) Europe http://www.cboermceurope.com, I delivered a presentation on funds that are engaging in options- and volatility-based investment strategies.

FOUR RESOURCES

Investors have four relatively new resources listed below that can help answer the question -“What funds are engaging in options- and volatility-based investment strategies, and how is their performance?”
1. Paper by Keith Black and Edward Szado. Performance Analysis of Options-Based Equity Mutual Funds, CEFs, and ETFs (2015) www.cboe.com/funds
2. Papers by Goldman Sachs - Mutual Fund Use of Options (2012 and 2014)
3. Paper by University of Augsburg - The Benefits of Option Use by Mutual Funds (2015)
4. Four New CBOE Eurekahedge Volatility Indexes that measure the performance of hedge funds that employ volatility-based investment strategies (2015).

Lists of funds are available at links at both www.cboe.com/funds and www.cboe.com/EH, but note that the lists are provided for informational and educational purposes only, and that CBOE does not endorse or solicit for the listed funds, and also note that past performance is not predictive of future returns.

PAPER BY KEITH BLACK AND ED SZADO

Keith Black and Edward Szado co-authored a paper - Performance Analysis of Options-Based Equity Mutual Funds, CEFs, and ETFs (2015) www.cboe.com/funds. An annual chart in the study shows that the number of Options-Based ’40 Act Funds grew from 10 in 2000 to 119 in 2014.

Key findings of the new study include:

1. 15-YEAR ANALYSIS OF FUNDS. The study performed an analysis of the equal-weighted performance of 80 Options-Based Funds that focus on use of U.S. stock index options and/or equity options during the 15-year period from 2000 through 2014, and found that –

2. HIGHER RISK-ADJUSTED RETURNS. The Options-Based Funds had similar returns as the S&P 500® Index with lower volatility (see chart below) and lower maximum drawdowns. The Options-Based Funds had higher risk-adjusted returns, as measured by the Sharpe Ratio, Sortino Ratio, and Stutzer Index.

3. ANALYSIS OF OPTIONS-BASED BENCHMARKS OVER 26½ YEARS. The study also performed an analysis of the performance over the period from mid-1988 through the end of 2014 for various options-based benchmark indexes that use S&P 500® (SPXSM) options and for some traditional benchmark indexes.

4. STRONG PERFORMANCE FOR BENCHMARKS THAT USE SPXSM INDEX OPTIONS. During the 26 ½ year-time period, both the CBOE S&P 500 PutWrite Index (PUTSM) and the CBOE S&P 500 2% OTM BuyWrite Index (BXYSM) had higher returns and lower volatility than the S&P 500 ® Index. A key source of strong risk-adjusted returns has been the fact that the index options usually have been richly priced.

GOLDMAN SACHS PAPER

The 2014 paper by Goldman Sachs on Mutual Fund Use of Options had a number of findings, including –

1. FUND FAMILIES. Five of the top 15 fund families now have funds that use options.
2. FUNDS. At least 196 funds use options, and these 196 funds had more than $480 billion in assets under management at the end of 2013.
3. STRATEGIES. The % of positions held by mutual funds in each options strategy – 64% in short calls, 22% in short puts, 8% in long puts, and 6% in long calls.
4. STRONGER PERFORMANCE. Over the 5-year period ending March 4, 2014, the funds that used options had higher returns, lower volatility, and higher risk-adjusted returns than their peer funds that do not use options.

PAPER BY UNIVERSITY OF AUGSBURG PROFESSORS

Here are some of the key findings of the paper by University of Augsburg - The Benefits of Option Use by Mutual Funds (2015) http://bit.ly/Augs-MutFd-Opt–

1. Use of options by mutual funds yields higher risk-adjusted performance compared with nonuser funds.
2. Option user funds show significantly lower systematic risk because they use options mainly for hedging strategies and not for speculation.
3. Consistent with covered call strategies for income generation, we show that mutual funds’ short positions are the main drivers of the performance-enhancing effect.
4. On the other hand, consistent with protective put strategies for hedging, long option positions are the predominant contributors to the risk-reducing effect of options.

CBOE EUREKAHEDGE INDEXES

CBOE recently launched four new benchmark indexes in collaboration with Eurekahedge, a Singapore-based hedge fund research and data collection company, that measure the performance of hedge funds that employ volatility-based investment strategies.

1. CBOE Eurekahedge Short Volatility Index (Bloomberg Ticker: EHFI450) -- The short volatility index is an equally weighted index of constituent funds designed to provide a broad measure of the performance of underlying hedge fund managers who take a net short view on implied volatility with a goal of positive absolute return. The strategy often involves the selling of options to take advantage of the discrepancies in current implied volatility versus expectations of subsequent implied or realized volatility.

2. CBOE Eurekahedge Long Volatility Index (Bloomberg Ticker: EHFI451) -- The long volatility index is an equally weighted index of constituent funds designed to provide a broad measure of the performance of underlying hedge fund managers who take a net long view on implied volatility with a goal of positive absolute return.

3. CBOE Eurekahedge Relative Value Volatility Index (Bloomberg Ticker: EHFI452) -- The relative value volatility index is an equally weighted index of constituent funds designed to provide a broad measure of the performance of underlying hedge fund managers that trade relative value or opportunistic volatility strategies. Managers utilizing the strategy can pursue long, short or neutral views on volatility with a goal of positive absolute return.

The CBOE Eurekahedge Volatility Indexes are equally weighted among their constituent funds and most have been reconstructed by Eurekahedge since 2005 using a rules-based methodology (CBOE Eurekahedge Tail Risk Index is reported from 2008). The combined assets under management (AUM) of the constituent funds exceeded $50 billion as of June 2015.

In 2008 the global stock market went down 43% but long volatility funds were up 46%.

After 7 years without a major correction in developed markets, investors are increasingly looking at volatility and downside protection, so to that end Eurekahedge are delighted to have teamed up with Chicago Board Options Exchange to offer this new suite of indices to address investors’ demands.

The CBOE Eurekahedge Long Volatility and Tail Risk Indices were up 45.81% and 12.58% respectively in 2008, while underlying markets floundered with the average hedge fund losing 9.77% during the year.

A similar result was evident in 2011 when the Eurozone debt crisis came to the fore over fears that a Greek exit was imminent, with the average hedge fund declining 1.88% during the year. In contrast, long volatility and tail risk funds were up 12.83% and 7.50% respectively.

Please visit www.cboe.com/EH for more details about the CBOE Eurekahedge Volatility Indexes.